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Four Fallacies of the Crisis

Author: Jagdish N. Bhagwati, Senior Fellow for International Economics
February 23, 2011
Project Syndicate

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The current twin crises in finance and the real economy, what Americans call Wall Street and Main Street, and the interminable discussions about financial reform and the prospects for economic recovery, have spawned several fallacies that need to be addressed and dismissed.

Fallacy 1:  The crisis would produce a “free fall.”

A free fall means just that. But, surely, the world economy, or even the United States or the European Union – to which this dire prediction was applied (by Joseph Stiglitz, for example, who wrote a book entitled Freefall) – has not been plummeting like Newton's apple. Animated discussions as to whether either or both economies face an L-shaped or a V-shaped recession have given way to the reality of considerable volatility, for both income and financial indicators, around a mild upward trend.

Fallacy 2: Through monetary expansion, the US is manipulating the dollar's exchange rate in the same way that it accuses China of manipulating the renminbi's exchange rate.

The two cases are dissimilar. If one grants the premise that there is an insufficiency of aggregate global demand, the alleged Chinese undervaluation of the renminbi can, indeed, be seen as a beggar-thy-neighbor policy, which diverts inadequate world demand to Chinese goods at the expense of other countries.

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